Exchange Rate Risk and Convergence to the Euro

ZEI Working Paper No. B 25

42 Pages Posted: 11 Feb 2005  

Lucjan T. Orlowski

Sacred Heart University - John F. Welch College of Business

Date Written: September 2004

Abstract

This paper proposes a new monetary policy framework for effectively navigating the path to adopting the euro. The proposed policy is based on relative inflation forecast targeting and incorporates an ancillary target of declining exchange rate risk, which is suggested as a key criterion for evaluating the currency stability. A model linking exchange rate volatility to differentials over the euro zone in both inflation (target variable) and interest rate (instrument variable) is proposed. The model is empirically tested for the Czech Republic, Poland and Hungary, the selected new Member States of the EU that use direct inflation targeting to guide their monetary policies. The empirical methodology is based on the TARCH(p,q,r)-M model.

Keywords: Exchange rate risk, inflation targeting, monetary convergence, euro area

JEL Classification: E42, E52, F36, P24

Suggested Citation

Orlowski, Lucjan T., Exchange Rate Risk and Convergence to the Euro (September 2004). ZEI Working Paper No. B 25. Available at SSRN: https://ssrn.com/abstract=665442 or http://dx.doi.org/10.2139/ssrn.665442

Lucjan T. Orlowski (Contact Author)

Sacred Heart University - John F. Welch College of Business ( email )

5151 Park Avenue
Fairfield, CT 06825
United States
203-371-7858 (Phone)

HOME PAGE: http://www.sacredheart.edu/ltorlowski.cfm

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